CFA 2018 level 3 schweser practice exam CFA 2018 level 3 question bank 06 asset allocation questions

Figure 1: Manager Comparison Data Portfolio Manager Expected Annual Total Return Expected Standard Deviation Expected Annual Turnover Management & Trading Costs A.. Calculate which port

ASSET ALLOCATION

QUESTION 1 IS COMPOSED OF TWO PARTS (A, B) FOR A TOTAL OF 10 MINUTES

Seth Batten, CFA, is working with two different clients The first, Client A, is a high net worth individual subject to a marginal tax rate of 50% (combined federal and state) on ordinary income and a 20% capital gains tax rate Client A has a risk aversion factor of 3 The second account, Client B, is a tax-exempt institution having a risk aversion factor of 7 Both clients have long time horizons

Clients A and B are each considering hiring one of the separate account managers profiled in Figure 1 All three managers use the S&P 500 as their index benchmark The S&P 500 is

expected to average a 9.0% annual return over the next 10 years

Figure 1: Manager Comparison Data

Portfolio

Manager

Expected Annual

Total Return

Expected Standard Deviation

Expected Annual Turnover

Management &

Trading Costs

A Calculate which portfolio manager Client A would choose based on utility adjusted return Show your work

(4 minutes)

B

i Based on the risk aversion factors only, identify which client is more likely to exhibit a low

tolerance for shortfall risk

ii Based on tax considerations only, identify which client is more likely to have higher turnover Justify your responses Consider each issue in isolation

Answer Part B in the template provided

(6 minutes) Template for Part B

Behavior

Client Most Likely to Exhibit Behavior

(circle one)

Reason

i Low tolerance for

shortfall risk

Client A Client B

ii Higher turnover

Client A Client B

QUESTION 2 HAS THREE PARTS (A, B, C) FOR A TOTAL OF 13 MINUTES

Jane Lo is responsible for strategic asset allocation with Global Asset Management (GAM) Lo

is looking at a domestic equity portfolio and considering adding either international bonds or equity to the portfolio Either is acceptable to the client, and Lo’s primary focus is improving the Sharpe ratio of the portfolio She reviews the historical data and expects the international bonds will have lower correlation with the existing portfolio than international equity will have She also makes the following projections:

E(R)

Investor’s domestic rf 1%

international equity or bonds, or determine there is insufficient date to make a decision

Support the determination with two reasons

(5 minutes)

Lo next turns her attention to one of the firm’s existing global asset allocation funds The fund manager is looking to add value through currency allocation and the carry trade The manager treats currency as an asset class Lo collects information on current 1-year interest rates and projected change in currency value versus the fund’s domestic currency

1-Year Rate

Change in Currency Fund’s Domestic Country 1.0% Na

recommend Calculate the approximate percent return the trade would net per unit of the

fund’s domestic currency

(4 minutes)

Six months have passed and Lo now projects a significant and generally unexpected increase

in currency volatility The same manager wants to profit from this view In addition to his existing carry trade, the manager is considering either a straddle, strangle, or collar option trade

i. Explain what the manager should do with the existing carry trade

ii. Explain which of the option trades being considered the manager should select

(4 minutes)